US Flow of Funds: wealth recovery fully underway, China?
by Rebecca Wilder
(crossposted with Newsneconomics)
This week the Federal Reserve reported the Q3 2009 Flow of Funds accounts. The headline indicators show household net worth improving and private debt burden falling.
The private sector – households and firms – is dropping leverage.
Update: This chart has been modified slightly – the leverage level data (highlighted in blue, red, and green) has been updated. 
Either by default or by growing saving, the private sector is de-leveraging. According to the D.1 table, households and nonfinancial businesses dropped debt a further 2.6% q/q annualized, while financial sector debt fell another 9.3%. However, total debt (of the domestic nonfinancial sector) grew 2.8%, as the federal and state and local governments grew debt 20.1% and 5.1%, respectively.
Household wealth grew $2.7 billion trillion for a cumulative gain of $4.9 billion trillion since wealth hit a cyclical low in Q1 2009. To put this gain in perspective, household net-worth dropped $17.5 billion trillion from Q3 2007 to Q1 2009, 3.5 x the recent gain. Wealth to disposable income, a statistically significant factor of the personal saving rate, rests right around it long-term (1952-1007) average, 4.9.
The chart illustrates the wealth-effect as the ratio of net-worth to disposable income. The direct and adverse impact of the wealth loss on consumption probably peaked last quarter; however, the lagged effects are ongoing.
Notice that the ratio shifted discretely in the 1990’s, not coincidentally when China’s current account surplus took off.
Most likely, the wealth to personal income ratio has mean-reverted, and will not rise back to its 5.7 1997-2007 average. A necessary condition is that global portfolio flows rebalance – i.e., China saves less and the US saves more. However, this will not happen tomorrow – de-leveraging is a process that takes years. The increase in international saving (i.e., falling current account deficits) will take some time, and by definition includes the general government eventually dropping its debt burden. Not to mention the political rhetoric and growing trade barriers suggest that a long-term economic shift is a ways off.
Rebecca Wilder
Hi,
Can you fix your charts so they are larger when you click on them?
Larger charts : most browsers now can increase the size of everything at the same time. Firefox has a menu across the top with View. In that menu you will see Zoom. In the Zoom menu you will see the keystrokes for making web pages larger and smaller. I don’t know about Microsoft’s Internet SpyExplorer. I stopped using it when the NSAkey was made public quite some time ago.
For years I’ve suggested to the browser makers that they should put the Zoom In and Zoom Out buttons on the toolbar. I use it all the time.
@Rebecca Wilder : Thanks for the charts. I don’t think that deleveraging will take years. I do think an entire industry will grow up around ‘strategic defaults’ in the next couple of years. It could even become fashionable. Until it becomes illegal. Then people will simply start burning buildings down? It speeds the process up a notch?
All of the mortgages should get cram-downs. Instead they get ‘mods’ that turn non-recourse mortgages into recourse mortgages (ie you can’t get rid of the debt even if you declare bankruptcy). The ‘mods’ have nothing to do with helping people? A mod mortgage is considered less risky by the bank so they can leverage it higher?
Might be worth a blog post comparing the derivative value of a mod mortgage (recourse) to a non-mod mortgage (non-recourse)?
What a (expletive deleted) bunch of scams…
Actually a in a recourse mortgage the only way to get out of paying is bankruptcy. I believe that student loans and federal tax debt are the major undischarable debts. In addition in most states mortgages are recourse anyway, only 10 have non-recourse mortgages. Note that there is another gotcha that will hit those who walk away after using the house as an ATM. The law on not taxing the difference between the value of the foreclosure and the amount of the loan only applies to purchase money, so if you used the house as an ATM you get to pay taxes on your atm withdrawal. (Which debt survives bankruptcy)
@Lyle – thanks for the clarification. That bit about the home ATM is a good reminder!
I actually found some good stuff summarized nicely in some Calculated Risk blogs
a) Mr. Ed – a horse is a horse, recourse, of course
However, there is much more to recourse than declared (or obvious) recourse? This is one of the main problems for the judges these days? You might enjoy this old article from Calculated Risk. I’ve plugged in a couple of quotes from the old post (from 2007!)
http://www.calculatedriskblog.com/2007/06/modifications-buybacks-true-sales-and.html
Quote 1 :
Whether we are talking about modifications or repurchases or both, all of this raises some ugly accounting issues, it seems.
Quote 2 :
Traditionally, when there is “recourse” in a sale, it generally has to be treated as a financing rather than a true sale, since the seller retains not just an obligation for performance of the collateral but presumably then some rights to make good on that obligation in ways (substitute loans, repurchases, mods) that may benefit the seller as much as the buyer. My guess here–I’m just reading the news, folks, so it’s a guess–is that the Financial Accounting Standards Board is fixin’ to possibly decide that some of these “nonrecourse” transactions are, actually, recourse transactions, and not true sales, and therefore not on the right balance sheet, and ugly ugly ugly.
b) The legendary Tanta in early 2008 with some details about Mortgage Forgiveness Debt Relief Act of 2007 (which is what you are referring to?)
http://www.calculatedriskblog.com/2008/02/bair-on-principal-reduction.html
Quote 1:
At the end of it, Bair’s proposal is just a recognition that we have blown through all the “credit enhancement” that first lien lenders thought they had. In order for there to be any “risk-based pricing” on the resulting loans–which are all subprime, now–the Fed will have to keep cutting rates to zero, as far as I can tell. The best case scenario for first-lien lenders (banks or securities) is then a long lean period of years in which you have low-yielding fixed rate loans outstanding that won’t go anywhere until amortization (rather than appreciation) builds up some equity. Great. We’re all GSEs now.
Namke here : it’s days from 2010. Amortization isn’t working either (check the rising default rates, ARM et al resets/recasts coming up, CRE and shadow inventory numbers)? Which leaves what? I have my suggestion (called the Namke Debt Consolidation Idea) which I just pulled back into the private section on my blog. It must be a really horrible idea – zero buzz analysis on the blogs. We’ll see how Team Fed/Treasury does in 2010. I think Marc Faber sums it up nicely (seen on Jesse’s Cafe Americain blog) :
“Mr. Bernanke, an academic who has never worked a single day in his life. He will take anything off a cliff: a business, a McDonald’s stand, the Federal Reserve. And I have to say I have a certain sympathy for him as a character. He’s ok, but completely useless. I would not even hire him as my butler…Mr Bernanke is a madman, a destroyer of the value of money. And he is a wealth destroyer and an economic criminal. It is the duty of a central bank to keep the value of money. I believe today for ninety percent of Americans life is harder than it was in 1999. Basically I think they are a bunch of crooks.” Marc Faber on King World News
May all beneficial wishes come true in beneficial ways!
Namke von Federlein
***A necessary condition is that global portfolio flows rebalance – i.e., China saves less and the US saves more. However, this will not happen tomorrow – de-leveraging is a process that takes years***
What motivation do the Chinese have to save less? Seems to me that they are doing just fine the way things are going now. Talk about saving less? Sure they’ll do that. Maybe go through a few charades. Do a Potemkin reform or two. But other than the fact that they will eventually lose some of their savings when the US and other developed countries stiff them on repaying a few loans, what incentive do they have to change their ways?
(And if they do quit “saving” isn’t it likely that they will do so by going on a shopping spree buying up US/EU companies and real estate at fairly depressed prices? Are we sure that’s how we want to “fix” the current account deficit? )
And for that matter, how much of US “savings” comes from debts simply being written off as uncollectable?
BTW, don’t the numbers seem awfully small? $2.7B is what? 0.025% of GDP? I must be missing somethng.
Those HH net worth gains and losses should read trillions, not billions.
Thank you! I will fix that immediately. Big typo…
Hi VtCodger,
The only incentive that the Chinese have to save less is to avoid dependency on the rest of the world for growth. It seems to me that export income will simply not sustain growth levels that keep China afloat (according to G7 forecasts) – therefore, domestic demand might play a larger role. To be sure, countries like Germany still earn 50% of their income through exports.
Its not just China – it’s the middle east and the rest of Asia, too. And trade restrictions are likewise preventing equilibrium flows. Over the week I read two articles in the FT about rising trade barriers between the US and China. There is no real “reason” for China to save less – but if they want to grow in the medium term, they must. to me, that’s why it will take a “long time”.
There’s still a lot to sort out. Not going to happen tomorrow.
Thanks for finding my billion typo. I get so used to talking in “billions” these days.
Rebecca